The Bank of England is caught between a rock and a hard place

So, once the FOMC had on Wednesday decided to leave monetary policy unchanged and the Bank of England’s MPC had yesterday opted to do the same, where does that leave us? It leaves us with the US economy seemingly racing along at nearly 5% annual GDP growth and the UK struggling to flatline. The politically incorrect observation, at least from a UK perspective, is that when an American loses his or her job, they set themselves up in the garage and start a business whereas their British counterparts go home, switch on daytime TV and bemoan that the available raft of social benefits is not enough. US consumer loan delinquencies point to some serious underlying problems but at the headline end all looks sort of okay.

Yesterday and in the aftermath of the BoE’s rate decision Governor Andrew Bailey zipped up his best Eeyore suit and delivered a depressingly downbeat assessment of the outlook for the UK’s economy. The media of course leapt on it although more sanguine minds will have had to conclude that the Old Lady has in the recent past followed a well-trodden path in talking down the nation’s economic outlook and for also having got it dreadfully wrong. Sure, things are not bright but if what the Bank’s economists predicted had come to pass, we’d be a hell of a lot deeper in the doodoo than we already are.

Econometrics eats its own children. I yesterday talked at some length to a seasoned Bank of England watcher. By the end of the conversation, I had a sinking feeling that I understood less that I had done when we had begun. One of the UK’s great conundrums is the proportion of the workforce that is registered with long term sickness and therefore unable to work. That figure is running at 6%. Yes, 6% of the working population is not contributing to the national tax take but is drawing on it. I know I risk having old-style heartless capitalist stamped on my forehead, but the equation is simple. The burden on those who do work in supporting those who don’t is growing and as we know from years of experience, the higher taxation rises, the further entrepreneurial motivation drops.

I am old enough to have professionally travelled fairly extensively in pre-’89 Eastern Europe – I even worked for a couple of years for the National Bank of Hungary’s London subsidiary – and although there is lingering nostalgia for the good old days of Soviet hegemony, I can assure you that life was pretty grey and miserable. It is true that, luxuries aside, most people could afford most of what was on the shelves in the shops but only in as much as there was anything on those shelves to start with. I have not been to the former GDR in a good few years but even when I was last there, the queues for bread or meat which I remembered from before the Wall came down had long gone. America’s stunning economic rebound from the Covid lockdowns, which by the way a large proportion of the population never abided by, speaks highly for a system where benefits are not entirely cradle to grave, where they help to bridge early stage unemployment but where the need to spit in one’s hands and to get back to work is strong. I digress.

My chum and I talked through the options available to the BofE and agreed that it is caught between a rock and a hard place. We also agreed, as we do pretty much every time we talk, that GDP is a fatuous measure and one which often flatters to deceive. I am known to dislike it and have long pleaded for the economy to be measured by value added created. My interlocutor, however, raised a point which had previously never appeared on my horizon. He suggested that GDP as such means little and that the measure should be per capita GDP. I suppose to a large extent that is reflected in the productivity numbers which are very weak, but I agree with him that if they were expressed in a deflator adjusted per capita figure, the state of affairs would be far more lucidly displayed. Including net migration, he reckons the UK workforce to be growing by around 1,000,000 a year. If GDP is standing still, it is in per capita terms obviously falling.

I think I am now on thin ice….

Meanwhile, Maggie Pagano, executive editor and fellow columnist at Reaction, wrote a strong piece yesterday which pleaded with the Bank of England to cut rates. She opens by telling the very sad story of the demise of the window and door manufacturer Safestyle. Apart from the utterly despicable behaviour of the management of the business who went into hiding and left it to the receivers to tell the workforce, assembled in the forecourt but not allowed into the building, that the company had gone to the wall and that some wages could not be paid, one could only feel for the pain of those who lost their jobs. It was a horror story and one of many which are being played out day by day all over Britain. Maggie makes the case quite clearly that the high cost of money has kicked the stool out from under the construction sector and that it was collapsing demand that ultimately killed Safestyle and slung hundreds out of work.

She is of course right but there is another angle, and without specific reference to Safestyle, from which the issue must be looked at. Our economies – it applies not only to the UK – are riddled with businesses which have overborrowed, which have never provided for tougher times, where managements have for years been helping themselves to bonuses provided by cheap liabilities rather than productive assets and where workers have shown up in the belief that in doing so they were doing the business a favour. Please don’t get me wrong. I am not trying to generalise, but the argument is not new that our business landscape is littered with zombie companies which in a harsher interest rate environment would have long ago gone under.

We need periodic slowdowns or even recessions in order to flush out businesses which without cheap and plentiful loans would long have been found out to be unviable. Tall trees need to be felled in order to give saplings light and a chance to thrive and in the economy it is no different. If there is demand for the product, the gap left by a failing business will quickly be filled. If there is not, it was anyhow time for it to fold.

The harsh years of the 1970s which saw the deindustrialisation of the British Midlands and America’s Rustbelt as well as Lorraine and the Saarland are often spoken about but if the businesses had been able to produce what was needed at a competitive price, they’d all still be there. They couldn’t and they aren’t.  Every business which disappears opens a space for a new generation of entrepreneurs to upgrade the business landscape and to thrive.

There will of course be an uncomfortable hiatus for the workers to go through and many of them will stumble over the hardships ahead. We will read reams about those who failed but little about those who did not. There is a labour shortage across the economy. Those who want to work will find employment and live to fight another day. The investors’ money, however, is irretrievably gone.  

Anybody who has ever traded in markets knows how to hedge risk and how to calculate the cost of hedging that risk. The higher the risk, the higher the potential reward. I consciously say potential. Many, myself included, have taken entrepreneurial risk, and lost. The lowest risk is I believe being taken by those who work in the public sector. Private sector workers all bear a share of the entrepreneurial risk, even if they don’t know it. It is absolutely debatable whether most private sector workers, ignorant of the risk they are bearing, are properly rewarded for it while many of their bosses, patently aware, are busily helping themselves. As far as shareholders go, they continue to let themselves be blinded by the misconception that share buybacks are for their own good and that cash, even mountains of borrowed cash, is better employed boosting the share price through the bid than being distributed in dividends.

Ooops. I’m back on thin ice.

Meanwhile, I have clearly been caught wrong-footed by the fierce rally in longer dated bonds with the US 10 year, not long ago to my vocal satisfaction having breached the 5.00% barrier, now back down at 4.66% and with the world and his wife still struggling to get on board. Notably the 2s/10s curve has re-inverted to -33bps. On October 19^, the 10 year gilt hit 4.70% but at the time of writing is trading at 4.38%. So, the US economy is on fire and bonds rally while the UK economy is apparently struggling to breathe, and bonds also rally.

“Higher for longer” is needed for the economy to cleanse itself of zombie companies. In the US it was Bed Bath and Beyond that exposed how wrong some companies have become and in the UK it was Wilco. The former was leveraged to death to fund share buy backs; the latter’s business model had simply passed its sell-by date. If a leaner, meaner Safestyle is in demand, then it will be bought out of administration, many of the laid off workers will be called back, and it will again thrive. If not, as I had already observed, then it was no longer required. Providing cheaper money Is not the solution but too much having been sloshing around for too long is often at the root of the problem. Good old Schumpeter, who advocated “creative destruction” to refresh the economy, was not all that wrong.

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